What is an initial public offering?

The popular Australian fast food chain Guzman y Gomez has announced Later this month, it’s going to undergo an initial public offering, or “IPO”, and shall be listed on the Australian Stock Exchange (ASX). This move will value the corporate at A$2.2 billion.

An initial public offering – sometimes also called an organization offering – implies that a non-public company lists its shares on a public stock exchange for the primary time.

However, this is an expensive process that also allows public investors to “look into the books” and analyze intimately the corporate’s financial performance.

So how do IPOs work and why do firms do them?

Most firms are privately held, but technically all of them have shares

Technically, all firms have “shares.” They simply represent shares of the corporate and its profits. An organization can have one shareholder owning one 100% interest, or 1000’s of them, each owning different percentages of the corporate.

The overwhelming majority of firms are privately held, which suggests their shares can’t be traded without private negotiations. The company’s listing on the stock exchange implies that anyone can now easily trade its shares on the market price by placing an order on the stock exchange.

At a high level, the stock price represents a good portion of all the longer term money flows the corporate is expected to generate, expressed when it comes to their value today (what we call present value). We do not know the longer term, so the worth of shares changes as expectations change.

Although an IPO marks the primary time an organization’s stock becomes publicly traded, a lot of the stock normally already exists.

For example, Guzman y Gomez’s prospectus (a really detailed report that firms which can be going public are required to publish) shows that after the IPO, the corporate may have roughly 101.3 million shares. But that is only about 10% greater than today.

Why do that?

Being a public company is difficult – it requires a full evaluation of the public investor market, which is often criticized as short-sighted and overly sensitive to short-term performance fluctuations. So why swim in any respect?

Asking CFOs who’ve been through this process normally reveals some common themes.

An IPO at the highest of the list helps the corporate establish an accurate market price for itself.

An unlisted company can have a reasonably good idea of ​​the worth of its assets. However, only when it comes under the changing eye of market evaluation will it obtain a more objective – and sometimes alarming – assessment of its true value.

The big good thing about knowing an organization’s value and issuing recent shares based on that valuation is that its original owners can sell a few of their shares as a part of the offering.

This has two advantages. It lets you convert difficult-to-sell company shares into money and offers you the chance to diversify your personal investment portfolio.

However, the presence on the stock exchange provides the corporate with excellent access to recent sources of funds. You can get a few of these advantages immediately by raising funds in an initial public offering – selling shares to recent investors. However, the stricter disclosure regime under which listed firms must operate also implies that the corporate is more likely to profit in the longer term from higher access to debt markets (comparable to corporate bonds) and equity (shares) markets.

Looking a bit more aggressively at the company route, a publicly traded company may eventually look to amass other firms. Being publicly traded implies that an organization can use its publicly traded shares, somewhat than money, to make an offer to a different company, which is called a “stock offering”.

Many of those shared advantages are relevant to Guzman y Gomez’s initial public offering, which is expected to lift $242.5 million through the issuance of 11.1 million shares.

Approximately $42.5 million of those funds will go to existing shareholders realizing their investments. The remaining $200 million is expected to be split between covering IPO costs ($17.4 million) and funding future expansion of the restaurant network in Australia and possibly internationally.

This process is not low cost or easy

It is clear that IPOs usually are not low cost deals, as almost 9% of the $200 million raised is paid to numerous managers and advisors of the listed company.

So what does the corporate get in return for its money? Guzman y Gomez has two common lead managers – investment banks Barrenjoey Markets and Morgan Stanley.

So far, these firms have provided quite a lot of practical advice on structuring deals – for instance, how you can determine the variety of shares available on the market to institutions, brokerage firms, employees and franchisees.

But most significantly, additionally they advise on the offer price of those shares. Keep in mind that Guzman y Gomez is within the Mexican food industry, not an IPO, so it relies heavily on its investment banking team to assist get the value right.

Set it too high and the stock may remain unsold. Too low, and the corporate will “leave money on the table” by giving up the chance to sell shares at full value.

Fortunately, Guzman y Gomez’s management can get some sleep within the run-up to listing. The jointly managing investment banks have agreed to the deal for a fee, meaning they are going to step in and buy the shares at an agreed price if not one of the offers sold.

But that does not imply every part is stress-free. Although the subscription price for the brand new shares has been set and guaranteed at $22 per share, this doesn’t necessarily mean that the stock will proceed to trade at $22 after listing.

In Australia’s largest IPO last 12 months, chemical distributor Redox issued shares at $2.55, valuing it at $1.3 billion. However, by the tip of the primary day, prices had fallen by about 5%.

That’s what’s great about public markets. You’ll receive transparent, objective feedback from day one, whether you prefer it or not!